4 Shortcomings Of Intellectual Property-Focused Investing
By Scott Fishman, CEO of Envisage and Program Executive at The Wharton School
I’ve been noodling a list of subjects I’m interested in for this installment, and ultimately decided to tackle two that are quite closely related: why intellectual property (IP) isn’t the whole story, and getting real about competition.
Intellectual property is pretty foundational to qualifying many health care ventures as “investable.” The premise is that, in absence of an officially protected technology, an investment in the long-term prospect that characterizes most health care opportunities would be at too great a risk. In other words, the value proposition needs to include not just great technology and a capable management team, but a U.S. Patent and Trademark Office (USPTO) warranty of unique differentiation and merchantability.
In theory, this sounds like a good idea. But look at the case of Apple wanting a guarantee that no one would be able to make a smart phone competitor, at least for the duration of its patent. Despite long and expensive legal wrangling between Apple and Samsung — Apple’s primary screen supplier — over protection of the form factor, we have a pretty clear idea of how that one worked out.
At the end of the day, you may be able to protect against someone creating the same thing, or a thing that does something in the same way, but you can’t protect from someone solving the same problem. It doesn’t really matter whether that involves a minor tweak to software or device design, or creation of a new isomer. Given sufficient resources and time, I can stop you from replicating my software, device construction, or molecule, but I can’t stop you from creating a better way to diagnose, monitor, or treat a medical condition. Nor should I be able to, since your solution may end up being better than mine for health care systems, clinicians, or patients. And that’s a good thing.
4 Reasons Why IP Isn’t The Whole Story
1. The first defect in relying on IP to reduce investment risk is that it won’t stop a better solution from being developed or marketed — a caveat that is especially salient in the context of a multi-year development program for a device, or much longer for a therapeutic. I might get to the finish line only to find that someone else got there the day before me.
2. The second limitation of IP-focused investing is that the strength of IP depends on the foresight, expertise, and billable hours with which it’s been prosecuted. Most startups devote way too much money to legal support, mostly in the area of IP, in order to create a supposedly airtight envelope of invincibility around their inventions. But they usually don't have much money, and the quality of their legal representation depends on their network, access to a top firm, access to specific expertise within that firm (i.e., understanding of the technical intricacies, competitive landscape, and clinical implications of the technology), time pressure (often a function of fundraising imperatives) and, of course, the peccadillos of a particular patent reviewer — among a host of other factors.
The bottom line is that a startup company can spend a heck of a lot of time and money to achieve what they thought was an unassailable patent position, that isn’t. And that doesn’t even touch the bigger question of whether the point of differentiation has any value to the market. I’m pretty sure I can get a solid patent on a toaster oven with wings, and equally sure that almost no one would buy it.
3. The third problem with IP is that, even if I have a well-executed and bulletproof patent, that doesn’t mean my prospective competition is going to sit back and let me siphon off their market share. I saw a pitch recently for a nicely researched, designed, and executed prototype for a home diagnostic; it will compete in a market worth hundreds of millions of dollars, and currently dominated by a few major players. The company’s founder was smart, passionate, driven, and pretty firmly convinced that her positioning and IP would provide a reasonable path to market. She was right on the first count and, to my mind, dead wrong on the second.
This is because — even setting aside the formidable challenges of market exposure, advertising cost, and distribution — it’s virtually certain that if the company founder doesn’t make a distribution deal or arrange her product’s acquisition by one of the major players before launch, she will be completely buried by blunt force marketing and legal challenges to her IP as soon as she captures any meaningful market share.
This isn’t speculation; incumbents have hard-won franchises to protect, and protect them they will. Even if the legal challenge is without merit, startups are easily diverted from their mission and drained of their resources by well-funded nuisance legal wrangling. Yes, the startup may “win” in the long run, and may even recover some of its legal fees, but by the time the courtroom drama has run its course, the product may well be dead and buried, or superseded by another technology.
4. One final problem with IP is the financial burden of getting patent protection. It’s more like an albatross for startups. Faced with the need to chase funding, develop their technology, pay for licenses to complementary technologies, put at least a few bowls of Ramen noodles on the founder’s table, pay consultants with specialized expertise, build and test prototypes, and so forth, this crucial gate to investment called IP can consume an inordinate amount of the very limited capital any nascent company has managed to scrounge up. This fiscal drain can bloat to the point where there’s not really enough left over to fully finance product development, and thus achievement of the next milestone that will assure continued funding. It’s a vicious cycle.
I’m not arguing against professional services here; I’ve made my own living for decades as a consultant. My point, rather, is that there’s an enormous diversion of scarce and hard-acquired resources to support a prerequisite that may not ultimately make any difference. A lot of technologies are races to market that succeed by being first, making a “land grab,” and securing a dominant early position that has little to do with the absolute strength of their IP.
Get Real About Competition
...Which brings me to competition. Many first-time (and other) entrepreneurs make the fundamental mistake of being so enraptured by their invention that they are utterly convinced it’s not only the relative best, but probably the only best solution. How else could one explain a pitch I saw last week, with financials projecting a 50 percent primary market share of its therapeutic category within three years, versus a dozen or more variably effective existing therapies, all marketed by enormous pharma companies.
Of course, this company pitched a solution that was going to be less toxic, more effective, and easier to use. Cheaper would have been a better and more credible pitch, but even that presented a problem, in that much of this particular condition’s cost of treatment is in administration. The company also failed to note that adjuvant therapies don’t really cut that far into primary markets until they become a first-line standard of care.
Only a few things are really that good and, yes, those few transform medicine. For example, the immunosuppressant Cyclosporine, and not sudden advances in operative technique, made transplantation viable. It’s a remarkable — but rare — occurrence.
The point is, competition isn’t limited to the same device, diagnostic, or drug. It’s anything that serves the same market — doctors, patients, health systems — to accomplish in-part or in-whole the same purpose, in a more effective and/or efficient manner. Sadly, customer preference is not a determining factor anymore, unless the solution first satisfies the other criteria. How else to explain formularies that refuse the most effective therapy, outright, in favor of a less expensive (and less effective) alternative — or at least restrict access until a patient has suffered through trials of two or three of those less effective alternatives?
Don’t Place All Your Eggs In The IP Basket
Unless they’re researchers or academics, doctors don’t care about mechanism of action as much as they do about clinical impact. Also, unless they’re embroiled in a technology arms race in a hotly competitive metropolitan statistical area, or driven by their research profile and NIH grants, medical centers care less about cutting-edge medicine than about occupancy, utilization, and enhancing their reimbursement-related quality scores.
I would similarly posit that, unless they’re in it for the satisfaction of intellectual curiosity and contributing to the advancement of clinical medicine, investors, including this one, care more about your ability to arrive at a better solution than how exactly you’re going to do it — which makes it at least worth questioning why the startup funding ecosystem puts such an emphasis on IP in healthcare.